Question 1

A debt contract that specifies that the company can only use the funds to finance certain activities

Accepted Answer

A) is a private loan. 
B) contains a restrictive covenant. 
C) increases the problem of adverse selection. 
D) all of the above. 
E) only A and B of the above. 
A) is a private loan. 
B) contains a restrictive covenant. 
C) increases the problem of adverse selection. 
D) all of the above. 
E) only A and B of the above.

Question 2

Conflicts of interest in the Arthur Andersen accounting firm intensified when ________ became the firm's largest source of profits and large clients pressured ________ office managers to give favorable audits.

Accepted Answer

A) consulting; regional 
B) consulting; national 
C) auditing; regional 
D) auditing; national 
A) consulting; regional 
B) consulting; national 
C) auditing; regional 
D) auditing; national

Question 3

The Sarbanes-Oxley Act of 2002 was passed in response to scandals in the investment banking industry.

Accepted Answer

A) True 
 B)False

Question 4

An audit certifies that

Accepted Answer

A) a firm's loans will be repaid. 
B) a firm's securities are safe investments. 
C) a firm abides by standard accounting principles. 
D) the information reported in a firm's accounting statements is correct. 
A) a firm's loans will be repaid. 
B) a firm's securities are safe investments. 
C) a firm abides by standard accounting principles. 
D) the information reported in a firm's accounting statements is correct.

Question 5

Because of the lemons problem in the used car market, the average quality of the used cars offered for sale will be ________, which gives rise to the problem of ________.

Accepted Answer

A) low; moral hazard 
B) low; adverse selection 
C) high; moral hazard 
D) high; adverse selection 
A) low; moral hazard 
B) low; adverse selection 
C) high; moral hazard 
D) high; adverse selection

Question 6

Financial intermediaries (banks in particular)have the ability to avoid the free-rider problem as long as they primarily

Accepted Answer

A) make private loans. 
B) acquire a diversified portfolio of stocks. 
C) buy junk bonds. 
D) do a balanced combination of A and B of the above. 
A) make private loans. 
B) acquire a diversified portfolio of stocks. 
C) buy junk bonds. 
D) do a balanced combination of A and B of the above.

Question 7

A venture capital firm protects its equity investment from moral hazard through which of the following means?

Accepted Answer

A) It places people on the board of directors to better monitor the borrowing firm's activities. 
B) It writes contracts that prohibit the sale of an equity investment to anyone but the venture capital firm. 
C) It prohibits the borrowing firm from replacing its management. 
D) It does both A and B of the above. 
E) It does both A and C of the above. 
A) It places people on the board of directors to better monitor the borrowing firm's activities. 
B) It writes contracts that prohibit the sale of an equity investment to anyone but the venture capital firm. 
C) It prohibits the borrowing firm from replacing its management. 
D) It does both A and B of the above. 
E) It does both A and C of the above.

Question 8

Equity contracts account for a small fraction of external funds raised by American businesses because

Accepted Answer

A) costly state verification makes the equity contract less desirable than the debt contract. 
B) there is greater scope for moral hazard problems under equity contracts, as compared to debt contracts. 
C) equity contracts do not permit borrowing firms to raise additional funds by issuing debt. 
D) all of the above. 
E) both A and B of the above. 
A) costly state verification makes the equity contract less desirable than the debt contract. 
B) there is greater scope for moral hazard problems under equity contracts, as compared to debt contracts. 
C) equity contracts do not permit borrowing firms to raise additional funds by issuing debt. 
D) all of the above. 
E) both A and B of the above.

Question 9

Debt contracts

Accepted Answer

A) are agreements by the borrowers to pay the lenders fixed dollar amounts at periodic intervals. 
B) have an advantage over equity contracts in that they have a lower cost of state verification. 
C) are used much more frequently to raise capital than equity contracts. 
D) all of the above. 
E) only A and B of the above. 
A) are agreements by the borrowers to pay the lenders fixed dollar amounts at periodic intervals. 
B) have an advantage over equity contracts in that they have a lower cost of state verification. 
C) are used much more frequently to raise capital than equity contracts. 
D) all of the above. 
E) only A and B of the above.

Question 10

A financial institution can achieve cost savings by engaging in multiple activities. These are called economies of

Accepted Answer

A) scope. 
B) scale. 
C) complexity. 
D) information. 
A) scope. 
B) scale. 
C) complexity. 
D) information.

Question 11

Investment banks serve two client groups,

Accepted Answer

A) home buyers and mortgage lenders. 
B) people saving for retirement and pension funds. 
C) issuers of securities and investors in those securities. 
D) mutual funds and investors with relatively small amounts to invest. 
A) home buyers and mortgage lenders. 
B) people saving for retirement and pension funds. 
C) issuers of securities and investors in those securities. 
D) mutual funds and investors with relatively small amounts to invest.

Question 12

If potential revenues from underwriting greatly exceed brokerage commissions, there is ________ incentive for investment bank analysts to report ________ information about firms issuing securities.

Accepted Answer

A) stronger; unbiased 
B) stronger; favorable 
C) weaker; unbiased 
D) weaker; favorable 
A) stronger; unbiased 
B) stronger; favorable 
C) weaker; unbiased 
D) weaker; favorable

Question 13

Investment banks are guilty of conflict of interest when they

Accepted Answer

A) pressure their analysts to produce research favorable to their client firms. 
B) permit executives of client firms to alter analysts' research on their firms. 
C) prohibit analysts from making negative or controversial comments about client firms. 
D) all of the above. 
A) pressure their analysts to produce research favorable to their client firms. 
B) permit executives of client firms to alter analysts' research on their firms. 
C) prohibit analysts from making negative or controversial comments about client firms. 
D) all of the above.

Question 14

Liquidity services are services that

Accepted Answer

A) make it easier for customers to conduct transactions. 
B) conducts transactions for the customer. 
C) increase transaction costs. 
D) all of the above. 
A) make it easier for customers to conduct transactions. 
B) conducts transactions for the customer. 
C) increase transaction costs. 
D) all of the above.

Question 15

What is the free-rider problem? Describe some situations that this problem creates.

Accepted Answer

The free-rider problem refers to a situa

Question 16

The potential conflict of interest when a single accounting firm provides both auditing and consulting services is that the firm can

Accepted Answer

A) charge higher fees to its audit clients and lower fees for its consulting services so it can expand its consulting business. 
B) charge higher fees to its consulting clients and lower fees for its audit services so it can expand its auditing business. 
C) provide unjustifiably favorable audit reviews for firms that are large clients for its consulting services. 
D) pressure its clients into paying high fees for both auditing and consulting services. 
A) charge higher fees to its audit clients and lower fees for its consulting services so it can expand its consulting business. 
B) charge higher fees to its consulting clients and lower fees for its audit services so it can expand its auditing business. 
C) provide unjustifiably favorable audit reviews for firms that are large clients for its consulting services. 
D) pressure its clients into paying high fees for both auditing and consulting services.

Question 17

(I)The total cost of carrying out a transaction in financial markets increases proportionally with the size of the transaction. (II)Financial intermediaries facilitate diversification when an investor has only a small sum to invest.

Accepted Answer

A) (I)is true; (II)false. 
B) (I)is false; (II)true. 
C) Both (I)and (II)are true. 
D) Both (I)and (II)are false. 
A) (I)is true; (II)false. 
B) (I)is false; (II)true. 
C) Both (I)and (II)are true. 
D) Both (I)and (II)are false.

Question 18

If borrowers take on big risks after obtaining a loan, then lenders face the problem of

Accepted Answer

A) free-riding. 
B) adverse selection. 
C) moral hazard. 
D) costly state verification. 
A) free-riding. 
B) adverse selection. 
C) moral hazard. 
D) costly state verification.

Question 19

Because of the adverse selection problem,

Accepted Answer

A) good credit risks are more likely to seek loans, causing lenders to make a disproportionate amount of loans to good credit risks. 
B) lenders may refuse loans to individuals with high net worth, because of their greater proclivity to "skip town." 
C) lenders are reluctant to make loans that are not secured by collateral. 
D) all of the above. 
A) good credit risks are more likely to seek loans, causing lenders to make a disproportionate amount of loans to good credit risks. 
B) lenders may refuse loans to individuals with high net worth, because of their greater proclivity to "skip town." 
C) lenders are reluctant to make loans that are not secured by collateral. 
D) all of the above.

Question 20

Spinning is the practice of

Accepted Answer

A) investment banks allowing executives of potential client companies to buy underpriced initial public offerings of other companies' securities. 
B) investment bank analysts providing misleading information about a company to encourage more investors to purchase the company's securities. 
C) accounting firms encouraging its audit clients to also purchase its management advisory services. 
D) credit rating agencies providing higher ratings on a company's securities in order to develop a long-term relationship with the company. 
A) investment banks allowing executives of potential client companies to buy underpriced initial public offerings of other companies' securities. 
B) investment bank analysts providing misleading information about a company to encourage more investors to purchase the company's securities. 
C) accounting firms encouraging its audit clients to also purchase its management advisory services. 
D) credit rating agencies providing higher ratings on a company's securities in order to develop a long-term relationship with the company.

Exam 7: Why Do Financial Institutions Exist

A debt contract that specifies that the company can only use the funds to finance certain activities

Conflicts of interest in the Arthur Andersen accounting firm intensified when ________ became the firm's largest source of profits and large clients pressured ________ office managers to give favorable audits.

The Sarbanes-Oxley Act of 2002 was passed in response to scandals in the investment banking industry.

An audit certifies that

Because of the lemons problem in the used car market, the average quality of the used cars offered for sale will be ________, which gives rise to the problem of ________.

Financial intermediaries (banks in particular)have the ability to avoid the free-rider problem as long as they primarily

A venture capital firm protects its equity investment from moral hazard through which of the following means?

Equity contracts account for a small fraction of external funds raised by American businesses because

Debt contracts

A financial institution can achieve cost savings by engaging in multiple activities. These are called economies of

Investment banks serve two client groups,

If potential revenues from underwriting greatly exceed brokerage commissions, there is ________ incentive for investment bank analysts to report ________ information about firms issuing securities.

Investment banks are guilty of conflict of interest when they

Liquidity services are services that

What is the free-rider problem? Describe some situations that this problem creates.

The potential conflict of interest when a single accounting firm provides both auditing and consulting services is that the firm can

(I)The total cost of carrying out a transaction in financial markets increases proportionally with the size of the transaction. (II)Financial intermediaries facilitate diversification when an investor has only a small sum to invest.

If borrowers take on big risks after obtaining a loan, then lenders face the problem of

Because of the adverse selection problem,

Spinning is the practice of

Why Study Financial Markets and Institutions

Overview of the Financial System

What Do Interest Rates Mean and What Is Their Role in Valuation

Why Do Interest Rates Change

How Do Risk and Term Structure Affect Interest Rates

Are Financial Markets Efficient

Why Do Financial Crises Occur and Why Are They so Damaging to the Economy

Central Banks and the Federal Reserve System

Conduct of Monetary Policy: Tools, Goals, Strategy, and Tactics

The Money Markets

The Bond Market

The Stock Market

The Mortgage Markets

The Foreign Exchange Market

The International Financial System

Banking and the Management of Financial Institutions

Financial Regulation

Banking Industry: Structure and Competition

The Mutual Fund Industry

Insurance Companies and Pension Funds

Investment Banks, Security Brokers and Dealers, and Venture Capital Firms

Risk Management in Financial Institutions

Hedging With Financial Derivatives

Savings Associations and Credit Unions

Finance Companies

Filters

Conflicts of interest in the Arthur Andersen accounting firm intensified when became the firm's largest source of profits and large clients pressured office managers to give favorable audits.

Because of the lemons problem in the used car market, the average quality of the used cars offered for sale will be , which gives rise to the problem of .

If potential revenues from underwriting greatly exceed brokerage commissions, there is incentive for investment bank analysts to report information about firms issuing securities.